EURUSD: will it continue to fall in a straight line?

This time last week we said that the euro sell off may take a break that the pace of decline in the euro had to slow at some stage; however, we were well and truly wrong. Since last week’s ECB meeting the EUR has fallen 600 pips, and is making fresh multi year lows on Wednesday. If we keep up this pace then we could reach parity by the end of this week…

Interestingly, over the same period the spread between German and US 2-year bond yields has only narrowed by 7 basis points, which hardly seems to justify a move of this magnitude. In this environment you can throw away the FX rule book that currencies should move with yield spreads. The FX market loves a trend and the rapid decline in the EUR is evidence of this. The break through 1.0600 this morning suggests that we continue to see more people happy to sell into weakness, rather than waiting for a bounce, which is adding fuel to the EUR decline.

So why the decline in the EUR today?

Draghi was talking this morning and said that he supported the current ECB policy, which is weakening the EUR, saying that it supports the Eurozone recovery.

After today’s speech it does not appear that Draghi is willing to help prop up the EUR, which the market may see as another reason to sell the single currency.

An article in the Wall Street Journal by influential journalist Jon Hilsenrath said that the Fed is likely to drop the term “patience” in regards to the timing of the next rate hike, which could get the market excited about an early summer hike, potentially in June.

It’s also worth noting that we have seen the Citigroup economic surprise index tick down for the currency bloc, and tick up for the US, even though US economic data, on balance, continues to surprise on the downside.

As you can see, from a fundamental perspective the decline in the EUR looks like it has gone too far too fast, but that doesn’t take into account momentum, a powerful downward force for the single currency right now. If the spread between 2-year German and US bond yields falls by another 7 basis points in the lead up to next week’s FOMC meeting, then can we expect a break through parity, maybe beyond?

One thing is for sure, when this rally does pause for breath there could be an almighty short squeeze that could see the EUR claw back some recent losses, especially if the WSJ has got it wrong about the Fed meeting next week (unlikely, in my view). But between now and next week’s Fed meeting the path of least resistance is a weaker single currency.

EURUSD: the technical view, potential for a short-term bounce

The break through strong support at 1.0765 is a bearish development, below here support lies at 1.05 – a key psychological level – then 1.0336, the low from 31st March 2003. If we do get a short term bounce, as it looks like we might, then hourly resistance includes 1.0717 – today’s intra-day high. As long as we stay below 1.0765 then we expect to see further downside.

From a technical perspective, any strength in this pair will be short-lived, and we continue to expect to see parity. What EURUSD does when it gets to parity could be interesting. One would expect some hovering around such an important and symbolic level before the market makes up its mind whether to clear it completely or bounce from there. We will write about life after parity in another note, for now the EUR still looks toxic.

Takeaway:

The path of least resistance continues to be lower for the EUR.

The fundamentals may not justify such a big move, but it takes a brave trader to stand in the way of this wave of EUR selling, especially with the Fed meeting only a week away.

The market seems to be pricing in the prospect of the Fed dropping the term patience in next week’s statement in relation to the timing of rate rises.

From a technical perspective, the break below 1.0765 is a bearish development that opens the way to 1.05, then 1.0336 – a 12 year low.

Parity is still on the cards and we continue to expect any strength in EUR to be short term in nature.

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